Make your money work for you!

Month: October 2015

The new portfolio manager for Bondora was released, so of course emotions as usual are running high. My first thought was – holy sh** – this can’t be how the new PM works – you just have to go through two confirmation screens and essentially pick one option out of three to start investing. So, after my initial reaction I had a chance to get some answers from the CEO Pärtel Tomberg about the reasons why the new system ended up as it did. (You can read their official pre-release post here.)

The answers by are by Pärtel (unedited) and my comments are in italics. (Before we start, I gotta say the answers I got from Pärtel were impressively detailed, and a much better show of communication then anything I’ve seen in the past couple of years. Some of the ideas I don’t agree with but he does show their mindset quite well.)

1. What was the design logic for having more simplicity? Don’t most investors want to more actively manage their investments?

a. Our main goal is to deliver net returns higher than available on the public stock markets regardless if you manage your portfolio actively or passively. We want to deliver the results regardless if you are investing 1,000 euros or 1,000,000 euros.

b. Approximately 80% of the investments are coming from investors who only have used automated portfolios (passive investing) and 20% from investors who are actively managing their portfolios (loan picking, secondary markets, custom strategies on old Portfolio Manager etc.). We conducted extensive interviews and surveys in the beginning of the year and found out that the passive customers actually considered our product (Portfolio Manager) very complex and wanted a single control centre along with easy overview on top of getting access to Bondora’s returns. Active investors on the other hand wanted very granular reporting and loan picking options. It became evident that trying supporting both within Bondora website would be impossible as neither group’s needs would be satisfied.

(I have heard this complaint as well that the current PM as-is was difficult to use, and helped several people set their PM up.)

c. Therefore we made a decision to build a super easy and light weight product for the retail investors and create an API to support the more active, trader types. We will now release an API that is open to third parties to build services on top of our platform (e.g.http://www.lendtower.com/, https://beeplus.me/). The second version of this API (version 1.0 is in our sandbox) will be coming early November and will include Primary Market buying, Secondary Market buying, Secondary Market selling and setup to support third party developers. Later this year we will also roll out full reporting package after we have updated and corrected the reporting package on the web.

(So far we haven’t gotten much info on the API and the things third parties are doing with it. I had two developers mark that at this point the API wasn’t as good as it could be, but hopefully Bondora is accepting recommendations from the people working on developing the interactions for API.

Also… corrected the reporting package on the web? I’ll believe it when I see it 😉 )

2. Why did you decide to change the way account value was shown ? (meaning the 60+ loans being counted only as the unpaid-by-this-moment as opposed to the whole value of 60+ with maybe a combination of expected % of recovery?)

a. The objective of the dashboard is to give investors an immediate view of the profit of their portfolio. This profit is calculated using the net investments made by the investor to date (deposits less withdrawals) and the value of their portfolio.

b. Investments into loan portfolios are fixed income investments whereby an investor exchanges a certain amount of capital for a steady stream of monthly payments that are higher than the initial investment. The key here is the monthly payments. Part of this return comes from interest and part of this comes from reinvestments interest that in turn generates both new principal payments and interest – e.g. cumulative interest.

c. All loans are priced on the assumption that a certain proportion of loans are not repaid. The default and corresponding recovery is factored into the interest rate so that interest payments on performing loans are high enough so the total portfolio delivers the expected return.

d. As interest and reinvestments of repaid principal are made monthly then all provisions are matched to the same period. Otherwise we would compare lifetime losses of a portfolio with the interest income of a a couple of months. This logic would potentially work only with a very short investment focus but as investing on Bondora is a long-term investment then it does not make sense.

e. There are two financially sound alternative views to calculating the portfolio value the way we do in the new dashboard. First is based on IFRS rules for banks and the second based on repricing of all loans in the portfolio according to a similar logic we use for pricing new loans. We plan to roll out both methodologies by the end of the year so that in the future investors can choose which context fits their requirements.

f. In case you disagree with our logic and would want a simple alternative to check the net annualized return than simply compare the interest income of your portfolio with the amount of capital you have invested on Bondora (deposits – withdrawals) for a certain period. This would be ROCE logic (http://www.investopedia.com/terms/r/roce.asp).

g. PS! Discounting the balance of overdue loans and matching this number with income makes sense for mortgage and super-prime loans (e.g. ZOPA) where the income of the performing portfolio is negligible so a loss can effectively never be priced/repaid by income on the portfolio.

(I think this is a tricky issue – overall for new investors seeing a more balanced view, but long term this becomes a bit problematic because the number of what’s shown on the dashboard vs what’s shown in the pie chart will differ by a magnitude of 10x.)

3. How should the passive investor decide between the three risk classes? (What should be the ‘decision tree’ that leads them to a specific type of investment?)

a. First of all an investor should decide if and how much of their portfolio they would like to invest on Bondora. Passive investors typically invest between 5%-10% of their portfolio on Bondora and are not that much concerned of additional diversification (as they have already diversified by only allocating 5-10% to Bondora).

b. The three risk-return options allow you to decide if you want to build a portfolio that is on average less profitable (and risky), more profitable or at average profitability.

c. Each of these options comes with different expected returns however the actual risk of the portfolio (losing money on a portfolio vs. the gains) is always determined by the diversification level. Our statistics has shown that after 200 investments the volatility of returns stabilizes based on if you took the less or more risky route. However in most cases investors earn considerably more than anywhere else on the market and almost never lose money (enclosed).

d. In summary, investors should first decide if they want to by the types of unsecured personal loans that Bondora can deliver and how much they want to invest. If this amount is enough to diversify (we think that you should consider building up a total portfolio of at least 1,000 euro to meet this condition) then thereafter the actual risk of your portfolio is not influenced anymore by the types of loans you pick.

(Once again… the decision making is slightly problematic. When I try to think about which of the three options I should choose, I would probably struggle. Long term valuations of high risk – high reward can be hard to project the value into the present.)

4. Do you feel that the current one-window check screen for the investor to verify their understanding of risk is sufficient to guarantee that investors are adequately analysing the risks associated with investing? (How are less knowledgeable investors protected from making bad investment decisions?)

a. In order to invest on Bondora the investor needs to review the information on our landing pages that based on FCA guidelines include full information about risks and processes. You should be confident that you want to invest through Bondora when you sign up and you should only invest a certain share of your portfolio. Typically our customers invest 5-10% of their capital with Bondora and they consider this part of their alternative investments portfolio (potentially higher return but less liquid/higher risk).

b. The Portfolio Manager page includes information on the expected returns (that are net of losses), an overview of how the portfolio is expected to grow, the expected composition of your portfolio (by risk level and country), expected numbers based on levels of diversification as well as detailed explanations of how different numbers are calculated.

c. We believe all these steps and detailed information is sufficient to make an investment decision on a 5-10% proportion of an investors portfolio. This level of detail is considerably more extensive than you would find with the people selling pension funds (in supermarkets), online FX sites or online asset managers. We also think our information is considerably more detailed than any other marketplace lender.

(The last in particular is an interesting statement, that your P2P portfolio should be 5-10%. While most bloggers try to direct most investors into this direction, then not many starter investors follow this – for many the P2P section of their portfolio is anything from 50-100%.)

5. How does the risk balancing process work? How far “out of balance” will the portfolio tip before you stop investing into a group to wait for others to rebalance?

a. The system calculates your portfolios risk level after each batch of investment and only buys batches of loans with a risk level lower or higher than your existing portfolio depending on your strategy. In general customers who have signed up for the new portfolio manager are looking to decrease the risk of their portfolio.

(This would definitely be interesting to see. If this algorithm works well, then whoever designed it definitely deserves a raise. Also, when the previous PM was launched in January I also set it to be more conservative than my existing portfolio, so I guess I fall in to that ‘general’ subset of investors.)

6. The sizes of the loan pieces – take the sample of my portfolio, what would the investment per loan be (and why isn’t this visualised anywhere?)

a. The size of each investment is determined by the number of borrowers in your portfolio. The investment size is doubled after each 200 investments (the file enclosed earlier explains the logic). Your (as in me, Kristi’s) portfolio has 680 borrowers which means that your bid size will be 40 euro (or 0.72% of your outstanding portfolio). This level delivers an optimal investment time as well as risk diversification.

b. This number is not visualized as the people we interviewed when developing this product never raised the topic. We are happy to add this in case our customers request it. Most people never think of how much they would invest into granular assets within the category they are investing in. For example if you choose a pension fund you never think or decide on how many euro per month is invested for each stock or bond in the portfolio.

(Yes, please visualise this )

c. If everyone would sign up to the new product the roughly 83% of the investors would be at 5 euro investment size however this number is more equally spread when we look at the amount invested.

(Alright, so now this is probably the most controversial of all the issues. My current portfolio value as you see above is about 6,5K. This means that at the rate I invest, which is about 150 euros per month, with returned money reinvested I will be investing into a total of…. 6-8 loans per month. I’m not entirely sure how I feel about that, especially since I’m on track to get to the 80 euro pieces quite soon. On the other hand, I was super surprised at the data that so many of the investors are at such small portfolio sizes that they would remain at the 5 euro piece – this means that they have <200 loan pieces, meaning a portfolio of <1000 euros. The data shows an intriguing look into the investor base of Bondora – a lot of retail investors who invest small sums, and a small % of investors with significant portfolios that make up almost a third of the money invested. This is the part where you have to keep in mind though – the people complaining on the forums are those who are a very vocal minority – the majority just sits still and lets their money get invested without causing a hassle on the forums.)

7. Will the 80 euros per limit also apply when investing via API? Why was the decision made to lower the investment amount per loan? How many portfolios are likely to be investing at the max level of 80 euros per loan? (Also, if your account has less money than the assigned ‘loan piece size’ then will it still invest or wait for the money to stack up aka the problem of ‘cash drag’?)

a. The 80 euro per loan limit was set to ensure that the proportion of each new loan in the portfolio is not higher than 1% of the deployed balance in most cases for customers converting from old products to the new. Such restrictions do not apply when investing over the API – you may fund the entire loan if you want through that channel. As the data showed earlier – roughly 2.6% of investors would be investing at that level in case everyone would convert to the new product.

b. The new Portfolio Manager never invests fractional amounts to ensure the diversification rules are properly applied. This is already the case for most investors as the minimum investment amount is set already to 5 euro.

(I essentially read this as – the people who would use the API or those who would be investing the max 80 euros per loan piece are likely to overlap anyways so this is somewhat of a non issue.)

8. Does account value function imply that at one point selling whole portfolios will be possible? (Since 60+ loans are now sellable on the secondary market already.)

a. The new Portfolio Manager will in the future include the option to sell part of or entire portfolio. Other investors using the Portfolio Manager will then pick these up in case there are not enough loans on the primary market.

b. We are currently working on building the models to price outstanding loans so that loans on the secondary market would be priced according to the same logic as on the primary market. In essence this would mean that certain loans would be sold at balance value, some above and some below.

9. How many investors are you predicting will be using the passive web interface vs how many will be holing out to use the API?

a. We expect that roughly 80% of investors will use the passive web interface and rest will come through the API. Already after two days the new Portfolio Manager accounts for 45% of the new investments without any marketing.

(I think this % is very high – it’s a bit scary to seen that many people be so passive with their investments, but overall, Bondora is just about as passive for them as an average investment fund now, so maybe they shouldn’t be judged that strongly based on that. I’m tempted to try the new PM myself as well, just until the API is live since it will take time to test most third party apps for that as well.)

10. Many of these changes are likely a precursor to more institutional investors coming on board – are you running any scenarios to assess the likely future balance between retail & institutional investors?

a. We are building a structure where institutional and retail capital is collectively combined to allow consumers move away from banks. It is certain that institutional capital is going to be higher than ’self-directed’ retail capital as the markets are at very different sizes. However you should also understand that raising money from banks (who hold your deposits), pension funds (who manager your retirement plan) or insurance companies (who manage the funds to keep your home safe) are all retail investors simply packaged together.

(While this is already long then some final comments – 1. I do think that most people underestimate just how passive investors are, and a lot of our first impressions are strongly coloured by bad decisions made in the past by Bondora. While talking to Pärtel then he also mentioned that some reorganising is happening to manage investor relationships better. Though they have done this before, then I hope they do it better this time to generate answers for the more complex questions that investors are likely to ask. 2. If you feel like the new PM isn’t for you, then I recommend against activating it – but as you see from the data above most people are likely to activate and just be silent about it. 3. I reserve the right to guess more about these things once they’e been live for long and we can see a bigger impact of this on the way the market works.)

To finish up, a XIRR chart, kindly shared by Pärtel, to demonstrate the need for diversification:

Anger from retail investors, rampant speculation and doubts about competence of leadership and overall abandonment levels of the portal will probably start causing issues (if they already aren’t) for Bondora, and I think as the flagship of Estonian P2P investing, their failure to work well with investors is likely to destroy a lot of credibility for the whole field.

The pivot

When I started investing in Bondora three years ago, then the overall advertised mindset was that it’s an investment opportunity by the people for the people to make people happy. The core values that Pärtel Tomberg (CEO) talked about in pretty much every media presentation were being transparent, allowing investors to hand-pick as many loans as possible, give out as much data as possible and overall lead the way to a post-banking world, that plays to the strengths of retail investors.

For those who haven’t invested into Bondora for such a long time, this mindset might be a bit surprising, since you probably haven’t heard much about this, since the current statements are much more growth and expansion orientated. Retail investors have lost a lot of their importance despite having been instrumental in allowing Bondora to survive the first couple of years, and the overall opinion you can read from forums and blogs ranges from slight displeasure to aggressive anti-campaigning. What caused this?

The first reason is the pivot. There’s a time in every start-up’s life when something’s gotta give – you either accept more VC money and push for growth or risk remaining stagnant and falling behind competition that is trailing close behind, while having the advantage of learning from the mistakes you had made as a frontrunner. While Bondora hasn’t really made the statement (and they probably never will), they have clearly reoriented from retail investors – and it’s understandable, looking at the US experience then for true growth you need institutional investors who can fund loans in the millions, and retail investors just will not allow for the growth that you’re aiming for.

The second reason is leadership. No one doubts that Bondora is Pärtel Tomberg’s “baby”. Though the idea of crowdfunding had many starts, then he definitely hit a sweet spot when it comes to appealing to retail investors who stepped on board despite the lack of history and evidence based risk assessment. This was, however, eight years ago. Between then and now many funding rounds have happened and millions of VC money have been added. No one seems to want to ask this question out loud – how much power does Pärtel Tomberg still have in the company? I mean, I have no doubt that he still holds the majority of the business, but that’s not as valuable as it seems, considering how Bondora is bleeding money, and the minority shareholders are the ones financing the push to profitability. While start-ups aren’t expected to become profitable too quickly, then most VC’s would assume for less of a loss rate at the 10 year mark.

The third reason is, ironically the investors. I think that to some extent investors we’re too optimistic about just how viable such a business model is based on just the funds that retail investors are likely to provide. This causes a kind of an insurmountable gulf between the business model as it should be to be profitable and the business model as we would like it to be. People are expecting to have very much autonomy, much data to make individual decisions while institutional investors are much more interested in big data based models where their involvement has to be minimal and the returns rate is highly predictable. In theory this information model could work for retail investors as well, but due to terrible management, communication and the unexplained pivot retail investors have lost a lot of trust towards Bondora as a whole, and trust is difficult to regain.

Why is Bondora messing up such a problem?

One of the bigger problems that Bondora causing such chaos causes is ruining the view of the market for the people entering. Most people start from Bondora, since it’s the biggest, has the longest history and most information written about it. However, after investing for just a bit you end up bombarded with complaints and issues, you start noticing problems yourself and become disillusioned with the whole P2P or crowdfunding based investment field.

For a long time I recommended Bondora for beginners due to those same reasons but I’d rather not recommend Bondora at this point. One of the core values of investing is stability, and there isn’t a whole lot of that going around for Bondora, which I think is a bad precedent to create – that they want your money but refuse to do anything investors ask for, and at this point they’ve even finished giving direct information (they’ve even deleted their Facebook).

How to fix Bondora?

Honestly, from the outside looking in, I think they should just revamp a whole lot of things. Realistically there isn’t just one easy fix to make it work, and there are dozens of ideas already thrown out there by the investors, they might as well listen to some. And while they don’t then it might be food for thought that more and more people make it to my blog with the search term “Bondora bad experience”.

Clearly there are three weak points that compound the problem:

1) The IT team – whatever it is they’re doing, it’s not helping them expand. Fundamental functionality such as the cash flow page being broken has zero excuse, and honestly is basis for writing some pretty mean complaints into the Financial Inspection. If the team is good, then the IT lead or business lead are dropping the ball.

2) The investor communication aspect is nonexistent. News are found out randomly, requests for data go unanswered and the customer service answers are just about as “canned” as they can be. While they hired people to do investor communications then those people have disappeared into the black hole of Bondora’s office and no one knows anything.

3) The company lacks an overall vision, or if it has a vision then it’s definitely not known by anyone outside of the company. You can’t have everything at once, and trying to have retail investors give your money while not providing them with anything in return is quite a lot like trying to eat your cake and having if later, still.

Recovery is a topic that tends to divide investors into two camps. One half argues that no recovery is happening and that defaults are climbing at an incredible rate, while the others dig around the data and come to the conclusion that recovery happens, but it’s just overall brutally slow.

A lot of people also seem to be very optimistic about the impact that recovery will have on their portfolio. The best way of thinking about recovery (in my opinion) is hoping for an overall break-even. This means that overall, while with a time delay, you do not lose money on defaults. The actual returns come from the loans that are paying on time – and they are the majority.

This month though, my portfolio hit 1000€+ in defaults, which of course is not pleasant to look at. I have however been keeping track of recovery, and I’m not particularly worried here, it’s a matter of time. I threw together some quick Excel graphs to visualize my portfolio happenings.

How much do people really owe me?

This graph is a simple money recovered – exposure at default (recovery-EAD2). As you can see, in raw numbers the debts are big, and you can easily see them piling up to 1000 euros. Now, where things get interesting, is where you normalize the recovery to a 1 to -1 scale, to take into account the actual loan size as well. In this graph -1 means that absolutely no recovery has happened, 0 means break-even point and anything above that is bonus.

The timeline of course runs from left to right, so the oldest defaults (I have 149 defaults in total) are on the far left. You can clearly see that the older loans are much closer to being recovered, but there is significant time delay. (Take into account that the loans are lined up by the day I invested into them, not by the date of when they defaulted.) Overall to visualize this – the part between 0 and -1, the white area is what has been recovered and the blue is what should still be recovered. For me, the total recovery is currently close to 180€, but it’s clearly speeding up.

Sadly monthly recovery is a disaster to actually keep track of, but I’ve been religiously taking screenshots of the recovery table on your statistics page ever since it got launched to track the recovery information there. For the past 4 months recovery has been more than 10€ every month, which might not seem like much, but if we look at the time delay then it’s reasonable to expect that it will keep accelerating. (I mean, for a long time recovery was less than 1€ per month.)

Yesterday I attended Investly‘s first ever investor event. The goal of the event was to give investors a clue as to what’s happening with Investly and to probably create a bit of hype about factoring being released.

(Before I go further, I’d like to point out that these kinds of events are good marketing and go a long way in terms of creating goodwill towards a business! Even though it was somewhat chaotic, in a world where everything is digital, investors still want to see the people they’re trusting their money with!)

What is factoring?

Essentially factoring is one company selling its invoice to a third party to receive funds early. For example business A does a service for business B and bills them for x amount of euros, with a 3 month deadline to pay. The problem being, business A needs the money quicker than 3 months – therefore they sell the invoice with a slight discount to a third party and get the money instantly and the third party gets paid by business B once the deadline has arrived.

Generally in this scenario business A is a smaller company who needs to manage their cash flow and business B is a bigger company where the wheels turn very slowly. For an investor this means they put up the money to buy out the invoice from business A and get compensated once business B pays off the bill when the actual deadline hits.

Factoring by Investly Q&A

At the event Siim Maivel (CEO of Investly) talked a bit about their plans for factoring and the people got to ask questions about how it’s set to work. Since it’s a completely new product then it’s important to communicate all the potential risks of this type of investment. (This is my personal summary based on the discussion, not a word-for-word transcript, so keep an open mind).

Why factoring?

Multiple businesses were taking out loans from Investly for the purpose of managing their cash flow. They might as well have been doing it with factoring instead of taking out a loan.

Investly tested factoring as it currently is on the market and concluded that it’s a product that’s too complicated as-is, getting factoring from a bank requires too much legal knowledge to make it viable for most small businesses.

Factoring will start off in a closed beta – the system is ready and new investors will be let in based on a waiting list to test the scalability of the system.

How will fraud be detected? (the fake invoices problem)

To start, in addition to thorough background checks for both businesses to prevent issues there are minimum requirements to qualify for the service. Initial estimate is that the business will have had to report for at least 1 year of business, and have about 30-40k of cash flow per year.

What are the expected returns? Minimum invoice size?

Returns will be based on the sales discount, which is likely to be 1-2% for 30-day invoices and 2-4% for 60-day invoices. (On a monthly basis). This will include Investly’s fee as well, meaning that less than 1000€ is probably unreasonable to take into work.

What’s the potential market for this?

So far they’ve had a “sign up if interested” mailing list working on their site, and the interest has been ‘big’. Siim claimed that in England, 90% of the businesses who use factoring have not used it before due to difficult access, making the potential market bigger than current factoring market would imply.

How will defaults be avoided?

If a ‘client’ defaults due to fraud, despite Investly having done due diligence, ordinary debt collection processes will start.

If the client fails to pay due to a bad financial situation – Siim estimated this to be unlikely due to the company towards whom the invoice is placed is likely to be a bigger company and be less likely to suffer difficulties.

How quickly will the funding process work?

Due to the short term aspect, speed of processing requests is important. Hope is to do it in a day or two, future automatisation is planned, but currently not at the top of the list of developments.

What could be the monthly amount of invoices processed (is a 100K invoice likely to get funding)?

Currently there aren’t enough investors to probably work with such big sums. There are talks with anchor investors to get the initial ball rolling, so hopefully reasonably sized invoices will not be problematic.

What/who is an anchor investor?

Someone who can invest more than 100€. (Meaning, this isn’t an actual ‘status’ that gets perks of some kind at this point.)

Is there a limit for participation per invoice (can one person buy up a 3000€ invoice for example)?

Currently no such limit has been set. If the demand for a specific invoice is big, then the auctioning system will actually end up increasing the purchase price, making it a better deal for the company selling the invoice. (Apparently there’s a lot of complicated math behind it).

Would partial sales of an invoice be possible?

Not at the moment, not enough reason to put in the work for it. Would be easier if someone just split a bigger invoice into multiple smaller ones if a partial sale is important. (For example bill 2x50K instead of 100K if they just want to sell half.)

My personal opinion is that factoring as an idea is a great product. As a small business owner, I am familiar with cash flow issues, especially if you don’t have too many clients. The theoretical market share could be quite big, provided that they get the pipeline going, and manage to get enough investors. Since a lot of the invoices are relatively short term, it’s not as capital intensive in some ways.

I’m interested in how the IT system holds up and how the auctioning system will work, so I hope for more detailed information on that in a bit. Overall, it’s good of them to try to expand, since they’re tapping into a market where they have almost no competition. In some ways that’s good, in some ways problematic since they have to put a lot of effort into making sure everything works as it should.

September wasn’t a very active month for me in Bondora. Due to having extra expenses (plane tickets!), then I only added ~20€ into Bondora this month. I’m on the wait to see what Bondora will announce for the new market system before adding in more money, since I’m 80% decided on starting a second Bondora portfolio under a business account. That still depends on what Bondora is set to do with their investments.

As you can see, a sad moment has arrived – the 60+ overdue has finally hit 1000€. I’ll be honest, it hurts a bit to look at 😉 . Especially, knowing the upcoming changes for how overdue loans will be handled. Still, I’m currently enjoying some digging around the dataset so I’ll be taking a longer look into defaults and recovery soon.

The ‘bump’ of adding in some more money at the end of summer hit, making September a record month – total interest earned was 104,7€. Hitting 120€ by the end of the year from just Bondora is looking very unlikely, but I’m not too bothered by it since I’ve just added a bit of money into Estateguru, so that compensates for overall social lending.

As I said, not much money was added, so there is a bit of a drop-off. However, you can clearly see the impact of the new rating system by how the defaults are dropping off a bit. It of course hurts seeing 25€ pieces default, but I don’t track them too much.

Recovery is still going nice and slow. I’ll look into that a bit more soon, so I won’t go into more detail now. Overall, looking forward to new announcements! (Likely that they will happen after the Lendit conference though, so still a while to wait.)